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Prices Steady - Inventory Up - Rig Count Down - Dollar Down - Spec Down
During the week ending March 27th, the spot month diesel futures price decreased by 0.68 cents per gallon (-0.39%) while the deferred months changed by +2 to -2 cents per gallon making the forward pricing virtually unchanged. The one year forward price ended the week at a 12.77 cent premium to the spot price, from a premium of 11.10 cents at the end of the previous week.
The change in level and slope of the diesel forward pricing curve indicates steady demand expectations and steady supplies with respect to demand. Demand includes speculative demand which was lower on the week. When the forward pricing curve decreases in slope (more negative or less positive), this usually indicates tighter inventories and is generally positive for price. When slope increases, this usually indicates more plentiful inventories and is negative for price.
During the week ending March 27th, the spot month gasoline futures price increased by 0.02 cents per gallon (+0.01%) while the deferred months changed from +2 to -2 cents per gallon making the forward pricing curve virtually unchanged. The one year forward price ended the week at a 0.53 cent premium to the spot price, from a discount of 0.33 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates steady demand expectations and steady inventory levels with respect to supply and demand.
The US dollar decreased on the week which is positive for price. Inventories on the week were higher which is negative for price. The stock market, as a proxy for demand expectations, was lower which is negative for price. Speculation was lower on the week which is negative for price. US domestic crude production was higher on the week which is negative for price. Domestic production is up 15.04% year over year.
The attractiveness of making new hedges increased as prices were lower. From a flat-price basis, prices remain very attractive when compared to the last four years. The market has found a price range. Production is expected to continue to outstrip demand and inventories will continue to grow. There is a fear that land-based storage tanks will fill leaving more expensive alternatives which may drive down spot prices. Speculation was lower giving the hedger less competition with speculators for long positions. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging may become more attractive.
Weekly US petroleum demand decreased by 4.19% during the week ending March 20th. Domestic demand is up 2.86% vs. one-year ago and demand is currently 2.30% over the five year average.
Domestic production increased again to a new all-time high on the week. The number of operating oil drilling rigs in the US continues to decline and the decline is decelerating. During the week, the number of operating rigs in the US declined by 12 or 1.45%. The previous week's decline was 41 rigs. This will limit production growth and may cause sustained declines in production which would help in balancing supply and demand in the market which would support price. This will happen in the medium-term not the short-term. The market has been watching this metric very closely and the sharp downturn in the number of operating rigs has contributed to the recent price increase. While this is true, production continues to increase and inventories continue to grow. The market is taking the steps to balance the supply and demand yet increasing production and growing inventories will keep prices low.
Below is the one-year chart of spot diesel futures prices as of March 27th.
Below is the one-year chart of spot gasoline futures prices as of March 27th.
: : Inventories increasing by 6.12 million barrels while inventories were expected to increase by 2.37 million barrels on the week. The five-year average inventory increased by 1.24 million barrels. Inventories increased vs. the five year average and vs. expectations.
: : The market continues to be oversupplied by about 1.5 to 2 million barrels per day. Balancing of supply and demand may take many months and until the market solves this problem through price adjustments to decrease supply and/or increase demand to absorb the excess, prices will remain low and the forward pricing curve will remain significantly positively sloped. There is the very real possibility that crude oil land-based storage in the US reaches capacity and that spot prices would plummet.
: : Because of growing inventories, the speculative short position in crude has been increasing rapidly since the market expects spot prices to collapse when storage becomes tight and more expensive.
: : Prices were supported due to Saudi Arabia conducting air strikes against rebels in Yemen. This opinion switched around and became negative for price as it was discovered that disruption of oil supply from Saudi Arabia is probably less likely given their military action since they have indicated that they will use military force to attack the rebels and not allowing them to disrupt oil supply.
: : The Iranian nuclear treaty appears to be closer to completion. If completed, the expectation is that oil production and exports from Iran would increase which is negative for price.
: : Stock market decreasing by -2.23% on the week is negative for economic and petroleum demand expectations and prices.
: : The US Dollar decreasing by -0.63% is negative for petroleum price. Commodities are used as a hedge against inflation and against a falling dollar. A stronger dollar reduces the relative demand for commodities for this purpose and prices decrease accordingly. Conversely, a weaker dollar increases relative demand for commodities and prices increase.
Below is the one-year chart US stock market prices as of March 27th.
Below is the one-year chart for the US dollar index as of March 27th.
During the week ended March 20th, total petroleum inventories increased by 6.12 million barrels vs. a five year average increase of 1.24 million barrels and vs. an expected increase of 2.37 million barrels. Inventories increased by 4.88 million barrels vs. the five year average. Total inventories stand at 825.9 million barrels, up from 819.8 million barrels at the end of the previous week. The five year average inventory is 719.4 million barrels, up from 718.1 million barrels at the end of the previous week.
Current inventories are 14.81% higher than the five year average, up from +11.16% at the end of the previous week. Inventory levels are growing due to excess supply and low price where those who hold inventories are accumulating more which is essentially increasing a speculative long position in the market. Those who hold inventories have an incentive to do so since forward prices are higher than spot prices, holders of inventory can earn an attractive guaranteed return on their investment.
Short speculation in crude futures has spiked due to the expectation that available tank space will be filled and prices will collapse. The increase in this short position in crude is the main reason why the combined speculative net long position has decreased so sharply.
As of March 24th, the net speculative long position in petroleum futures was 135,686,000 barrels down 14,040,000 barrels (-9.38%) from the previous week. Speculation decreased for the fifth week in a row to a new four-and-a-half year low and represents 16.43% of domestic inventories. Speculation is 49.90% below its one year moving average. The corresponding spot month diesel futures price on March 24th was 170.65 cents per gallon, up 1.26 cents from 169.39 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 62.20% correlated over the past 52 weeks indicating that, on a statistical basis over the past year 38.68% of the price movement of diesel fuel is explained by changes in levels of speculation. A linear regression analysis over the past 52 weeks shows that if speculation were zero and the market forces causing speculation evaporated, that the spot month diesel futures price would be 170.00 cents per gallon or 0.65 cents per gallon less than current prices. The analysis would indicate that about 0.38% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 2 cents lower on the week.
The net speculative long position hit a new 52 week low during the past week. It has been variable over the past year ranging between 135 million and 453 million barrels with an average of about 271 million barrels, which is down about 4 million barrels on the week.
Linwood Capital, LLC is an institutional fuel hedging management, advisory, and consulting firm. Linwood creates and manages customized fuel hedging programs for institutional consumers of petroleum and natural gas.